no Agricultural policy and the decisions of agricultural producers as to income and investment

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1 no Warsaw 2014 Agricultural policy and the decisions of agricultural producers as to income and investment Włodzimierz Rembisz Agata Sielska Agnieszka ezat-jarzębowska

2 Agricultural policy and the decisions of agricultural producers as to income and investment

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4 Agricultural policy and the decisions of agricultural producers as to income and investment Authors: prof. dr hab. Włodzimierz Rembisz dr Agata Sielska dr inż. Agnieszka ezat-jarzębowska Warsaw 2014

5 This publication was prepared as a contribution to the research on the following subject: Application of economic modelling in the analysis of the premises of competitive development of the agri-food sector within the framework of the research task: Equilibrium of the growth of the national agri-food sector and its competitiveness in the EU and global dimensions The purpose of this research was to present the impact of agricultural policy on choices of agricultural producers regarding income and investment. The issue of substitution between political and economic rent, which are sources of income of agricultural producers, as well as relationship between the political rent and investment are analysed. Reviewer dr Mirosaw Drygas Proofreader Joanna Gozdera Technical editor Joanna Gozdera Translated by Summa inguae Cover Project AKME Projekty Sp. z o.o. ISN Instytut Ekonomiki Rolnictwa i Gospodarki ywnociowej Pastwowy Instytut adawczy ul. witokrzyska 20, Warszawa tel.: (22) faks: (22) dw@ierigz.waw.pl

6 Table of contents Introduction... 7 I. Agricultural producers income, and political and economic rent Components of income, defining assumptions Substitutability and complementarity of economic and political rent Definition of economic rent Income vs labour productivity and price level Concept of political rent II. Substitution between economic and political rent Marginal rate of substitution of both rents Substitutability of effects of the policy and labour productivity Cost of obtaining income effects of both rents Elasticity of substitution of economic and political rent Demand and costs of obtaining income effect from both rents III. Empirical illustration of formation of the substitution of both rents Empirical values of marginal rates of substitution of both rents Empirical values of the elasticity of substitution of both rents Graphic illustrations of substitution of analysed rents IV. Political rent and investment of agricultural producers Hypotheses and problem outline Political rent and consumption, savings and investments of agricultural producer Investment and production techniques, and labour productivity Mechanism of agricultural producers investment decisions Savings and investment in division of agricultural producers income Relationships of increase in savings and investment Dynamics of investment, technical equipment and labour productivity Selected models of savings and investment... 72

7 V. Empirical illustration of the relationship between political rent and investment of agricultural producers Changes in capital, income from political rent and investment in selected countries of the European Union Relationships of investment and political rent Relationships of investment and liabilities Investment, political rent, liabilities dynamics Recapitulation iterature

8 Introduction Income effects of agricultural policy are expressed in raising them above the level resulting solely from market regulation. This, of course, has impact on the choice of the sources of such income. All actions (e.g. in terms of progress, technology, management, marketing) leading to improved production efficiency and price relations of prices received (purchase prices) to prices paid (prices for means of production) to improve the profitability of production are the second source. The agricultural producer of course selects the most useful and effective sources, comparing their usefulness to the cost of their achievement. These income effects of agricultural policies, that is political rent, also influence the choice of the producer as to investment. They reduce the negative correlation between savings (ex-post and ex-ante loans) and investment needs, increasing the ability of credit and investment and reducing risk. This results in maintained in a sense complementary relationship between political rent and investment of agricultural producers. It has an important impact on the development of the basis for the technical relationship changes, including adding the capital factor to labour factor, which forms a stable base for revenue. The catalysing effect of rent on investments of agricultural producers is expressed therein. This is the reasoning subject and axis of this monograph. The issue of political and economic rent is approached more analytically than empirically, as if outlining a new area of interest in agricultural economics. In the first chapter, we attempt to present the impact of agricultural policy on choices of agricultural producers. The choice refers to the objective function of maximization of their income. The variables in this choice are the agricultural policy and improvement of the efficiency of production, including labour productivity, as a source of such income. We do not contemplate the meanders of agricultural policy instruments, currently the Common Agricultural Policy. We assume that regardless of the complexities and multiplicity of instruments and programs of this policy, they must ultimately have an impact on the objective function of agricultural producer. The final result is a given income effect, positive one, i.e. realized income is higher than when the policy would not be implemented. This affects the aforementioned choice of income sources. We use the simple analytical approaches related to microeconomics and agricultural economics. First of all, we apprehend realized income as determined by the productivity of labour at a given level of product prices and income derived from solutions of the agricultural policy, CAP. We show the relationships existing in this respect. 7

9 In the second chapter, based on the analysis of the first chapter, we raise the issue of substitution between political and economic rent, which are sources of income of agricultural producers. Assuming rationality of choices of agricultural producers, we assume that they will refer to the cheaper and more useful source with respect to its objective function which is to maximize income. It seems that political rent meets these criteria. It is a source of income whose cost of obtaining is lower than the improvement of production efficiency. In turn, the utility in terms of income is the same. Hence, the marginal income utility, as defined in the chapter, of both political and income rent is different, less favourable to the latter. This may make the producer strive more for political than economic rent. As a result, it may also weaken the need to improve production efficiency. Chapter three is devoted to the presentation of the results of empirical studies in the form of graphical visualization. They refer to the assumed hypothesis of the substitution ratio between political and economic rent or its alternatives of a complementary relationship between the two rents. Graphical presentations for the analysed groups of FADN farms do not give a definite answer as to the substitutability of the two rents, however, they show additional characteristics associated with the level of production efficiency. In the fourth chapter, we assume that political rent, that is income effects resulting from the agricultural policy by, among others, an increase in savings, can contribute to increasing investment of agricultural producers. It is about increasing savings and subsequent investments above the level that would have been possible if there was no rent. The positive, or as we call it catalysing, effect of political rent neutralizing its less desirable substitution effect in relation to economic rent can be expressed there. We assume that the goal of the investment is to improve the production efficiency, especially the labour productivity factor as a long-term fundamental source of income in agriculture. Improving the labour productivity factor results, as it is known, in large part from the increase in equipment of labour factor in the capital factor. In other words, this is due to the improvement of the technical relationships, i.e. the increasing relationship of physical capital factor to labour factor. Political rent may increase both the level of investment and consumption of producers above the level that would result from the accumulated savings (including loans, which are as it is known the inverted form of savings). We show these dependencies analytically by introducing appropriate indicators of propensity to savings and consumption due to the income effect of rent. We show a possible catalysing effect of political rent on these processes. We show a simplified mechanism of the producer s choice regarding investments and we refer to 8

10 specific models of investment of producers. We also present the relationship of savings and investment and of labour productivity incrementally. The last, fifth chapter is an empirical illustration of the relationship between income obtained from political rent and other characteristics describing individual farms. In light of the considerations in the previous chapters in this section, we present the changes of capital expenditures, the amount of investment and the amount of income received from political rent in recent years in the selected European Union countries. The chapter also examined the formation of investment depending on the income resulting from the political rent and liabilities (ex-post and ex-ante), comparing two potential sources of investment in individual farms. In the last step of the analysis, comparison of the rate of changes (increase) in investments and income resulting from the political rent, subsidies for investments, income and liabilities for farms in Poland was conducted. The study was conducted in groups listed by voivodeships in which farms are located and by the economic size classes. 9

11 I. Agricultural producers income, and political and economic rent 1.1. Components of income, defining assumptions Actually realized level of income of agricultural producers (income in agriculture) is now increased as a result of a variety of solutions of the Common Agricultural Policy (CAP), for example, most clearly in the form of direct payments. They have certain effects on income. As we assume, first of all direct transfers (payments) are carriers of these effects. It is denoted by the symbol: T. Incomes of agricultural producers are also reduced (to a small extent) by tax and other charges, which is denoted as P T. Thus, the income of agricultural producers can be recognized as: C ( T PT ) DR (I.1) where: T the value of different forms of transfers, subsidies and agricultural support giving the income effect (direct payments, price support, production quotas, import quotas and other regulations intervention) T, n T i i P T the value of various taxes and other charges imposed on a farm n P, T P i i D R incomes of agricultural producers (agriculture). We assume that income defined in such a way is the maximized objective function of an agricultural producer. This is an oversimplification because the producer s objective function has multiple criteria 1. However, it is necessary for extracting the essence of the problem, i.e. the possible substitution of two sources of income for the agricultural producer, that is as far as achieved income effects of agricultural policy weaken the need to improve the efficiency. This need, of course, involves market regulation. 1 Cf. Sielska A., Decyzje producentów rolnych w ujciu wielokryterialnym zarys problemu, RiG-PI, Warsaw 2012, p. 28 and further, where the problem of agricultural producer s decision-making is showed in multi-criterion terms as a space of assessment of decision variants. 10

12 This fact relates directly to the question of whether the producers respond to market needs and submit to its productivity regime, or fight for grants and subsidies. It is debated or contested in a part of the latest economic literature where it is noted that economic organizations, like the European Union, are moving away from the market regulation methods by introducing... many administrative instruments. The best example of this is direct payments, which implies that agricultural markets can exist in the world, but not in Europe. These methods interfere with the operation of natural market forces..., the flow of economic information between consumers and producers is distorted, making it impossible to take informed production decisions. Instead of responding to the needs of consumers, the producers are fighting for grants. This raises the need to... regulations, the administrative machine continues to grow. Then, receiving money only for the ownership of land leads to demoralization of farmers... moral decline of this group can be easily extended to the whole of society. Finally: moving away from market mechanisms makes the European Union more and more conformed to the centrally planned economy 2. Of course it is a question in itself for a separate theoretical study. Here we referred to that because it implicitly affects the choices of agricultural producers as to the sources of income and investment decisions Substitutability and complementarity of economic and political rent To address the issue of substitutability and complementarity of both rents as a source of income 3, or indeed variables for maximizing objective function of agricultural producer, we first address it analytically and then graphically. Therefore, let us distinguish, according to the above formula, the two primary sources of income growth. Firstly, improvement of the efficiency of production (at a given price relations obtained for the products to the prices paid for inputs), or economic rent 4, is the source. Secondly, the source is also 2 A. Jakimowicz, Podstawy interwencjonizmu pastwowego, PWN, Warsaw 2012, pp Rent means any benefit which an entity (individual, group or institutional) can obtain from activities in which it involves any means having alternative use, cf. R.D. Tollison, Rent seeking: a survey, Kyklos, v. 35, 1982, pp On the basis of this understanding rentseeking is a natural form of human activity, A. Zybertowicz,. Pilitowski, Polityczna pogo za rent: peryferyjna czy strukturalna patologia polskiej transformacji?, [in:] M.G. Woniak (ed.), Nierównoci spoeczne a wzrost gospodarczy, Uniwersytet Rzeszowski, from no. 14, Rzeszów 2009, pp Economic rents are the forms of income that result from the use of production resources for the production of goods and services, J. Wilkin, Pogo za rent przy pomocy mechanizmów politycznych, [in:] Wilkin (ed.), Teoria wyboru publicznego: Wstp do ekonomicznej analizy 11

13 means obtained from solutions of agricultural policy CAP, or political rent 5. We can also define it as 6 : where: D max f {( EP) g( )} (I.2) t R EP production efficiency in its technical basis as the ratio of the size of y the resulting production to involved production factors: K, which follows directly from the occurrence of the production function, g () income effect of the agricultural producer support associated with the implementation of various programs and mechanisms of the CAP, direct payments and other services performed by the paying agencies (in Poland are: the Agricultural Market Agency, the Agency for Restructuring and Modernisation of Agriculture) from EU and national funds, that is, ( T T.. T ) P. P K T Using {( EP) g( )} as a component of the above objective function, we can build the following dilemma of reasonably progressive agricultural producers. Will they be more oriented to the income benefits related to agricultural policy CAP (political rent), or the benefits of improving the production efficiency (economic rent). According to popular belief, the former seem to be easier to obtain than the latter. Regardless of whether this view is true or not, there is a different mechanism of investigation into both income benefits. This is an interesting question as such, which we leave for another occasion. et us note that production efficiency is determined by the production function of a given agricultural producer (manufacturing technology) Rt f ( Kt, t ) as a source of income growth depends on the producer and is an endogenous determinant. In turn, the benefits of agricultural policy, as well as polityki i funkcjonowania sfery publicznej, Wydawnictwo Naukowe Scholar, Warsaw 2005, pp Political rent is a form of benefit associated with the use of scarce resources (labour and capital) for activities not increasing products improving social welfare. The benefits occurring in the form of political rent is merely a form of income transfer from one to the other entity through the mechanisms of political power, J. Wilkin, Pogo za rent..., op cit.; S. Sztaba, Wstp, [in:] M. Raczyski, S. Sztaba, A. Walczykowska, W pogoni za rent, READ ME, Warsaw 1998, p. 36; Kosiec K., Raczyski M., Rynki polityczne. Strategie firm pastwowych w rywalizacji rynkowej, Universitas, Kraków 1998, p The assumption of additivity adopted here will be repeated later. 12

14 changes in ratios of prices received to prices paid, is a conditioning producerindependent, so it is an exogenous factor. In the context of these patterns, the analysed issue can be presented graphically as an alternative: a) Payments - the income effect of agricultural policy is complementary to the production effectiveness, so political rent supports increasing the production efficiency of agricultural producers, which can be pictorially illustrated as below, without specifying the correlation relationship (regression) 7 : Figure 1. Complementarity of political and economic rent Source: own elaboration. b) Income effect of agricultural policy is in substitution relation with production efficiency, which may mean that the resulting income effects of agricultural policy weaken the compulsion to improve the production efficiency in agricultural producers, which resulted from the analysis contained in the earlier, so we have a relationship as illustrated below: 7 We can adopt, for example, the following linear function: EP D a ), which seems unlikely. t t ( t 13

15 Figure 2. Substitutability of political and economic rent Source: own elaboration. The latter hypothesis, as shown previously and we confirm further on, seems to be more congruent to reality, because usually negative rate of substitution is derived. In a few cases, however, their positive values were obtained, which may indicate complementary relationships. As we will show later in the relevant visualizations, substitution is stronger in the case of agricultural producers having lower than higher production efficiency. The image becomes complicated in the case of producers of negative production efficiency, here the rent compensates for management irrationality Definition of economic rent The first element of the equation (I.2) economic rent, production efficiency is defined for convenience of the conducted thinking in value as the difference between revenues and costs of involvement of production factors: EP ( C R N ) (I.3) R C N R Of course, fixed prices occur here, hence technical relationships are reflected 8, because they imply from the technical data described, for example, by the production function. When we assume the volatility of prices (the price scissors), i.e.: 8 Therefore, the literature also implements the concept of technical efficiency. 14

16 c C / C R N (I.4) this record expresses the indicator of production profitability: OP ( C R N C ) (I.5) t R t t t N R It is an indicator observed on the surface of phenomena, of course the most important for the current functioning, but it has an output and direct character for income. However, it does not explain their foundations. In the TFP (Total Factor Productivity) convention the production efficiency can also recognized as: EP R C R C R R (I.6) N C N K C K C With the assumption of fixed price relations, i.e. prices received to prices paid (price scissors), in a dynamic approach relevant for TFP, we can define it as: EP R N EP R N R K ( ) R K (I.7) and: EP 0 TFP EP (I.8) when: R K ( ) R K (I.9) We can also express the growth rate (essentially logarithmic derivatives) of labour productivity as the difference between the rate of production growth and the rate of decline in employment of labour 9 : 9 The drop in employment contributes of course to an increase in productivity. 15

17 W W R R (I.10) Assuming that there are no data about income effects of agricultural policy, the rate of labour productivity growth should, somehow exclusively, shape the growth rate of labour wages, that is the rate of growth of agricultural producers income in the following way: W W C C (I.11) It is known that this is not like that in practice. The rate of growth of agricultural producers income usually differs in plus from the rate of the growth of labour productivity factor: C C W W (I.11a) Due to the nature of production in agriculture, the growth rate of labour productivity is also expressed as the difference between the rate of growth of land factor productivity and the rate of change in the employment of labour. That is as: where: Q Q Z Z R Z R Z W W Q Q Z Z (I.12) means the rate of growth of land productivity factor as the difference of the rate of production growth factor Z and the use of land factor. Z We will not elaborate on the matter of sources and measuring the improvement of production efficiency, limiting to the above characteristics of the process of improving the efficiency in terms of changes in the TFP index which simultaneously takes into account a lot of production factors. We only note that the improvement in efficiency is the source of income growth, triggering of which 16

18 concerns a long period in which technical changes are possible (manufacturing K techniques in the above formula of changes in relationship: / ) as a result of K investment. It is a source invisible on the surface of phenomena, as opposed to changes in relationships of product prices and production factors. It should be noted that the change in the efficiency relationships based on the incorporation of new technical solutions in the production process is associated with capital investment, which will be the subject of attention further in this paper. The relationship of income to labour productivity in the mainstream economic literature is recognized as unit labour costs. It is one of the most important determinants of competitiveness indicators of the producer, sector or economy. It is important whether unit labour costs increase. If so, the wages grow faster than C C productivity. In our nomenclature, these indicators are as follows: and. W W As it seems, these indicators are not observed in Polish agriculture Income vs labour productivity and price level For further analysis, let us make the following assumptions. We can assume, in accordance with the theory of microeconomics, that the income of agricultural producers is essentially dependent on the labour factor efficiency and on a certain level of product prices under the principle of ceteris paribus 10. Thus, we can express it as: C W C (I.13) R and: where: C R t W (I.14) t an agricultural producer s income as remuneration of labour factor, 10 abour productivity reflects the impact of other sources and circumstances discussed at another, lower level of horizontal aggregation and abstraction. We can refer to such factors as: market position, the efficiency of organizations and finance, sales volume, different types of progress, knowledge, qualifications, collections, etc. 17

19 R t production (sold), t employment of labour (full-time, AWU or other type), C R level of agricultural prices at a given time. abour productivity is of course internal source of income dependent on the agricultural producer, at least in the range allowed by the manufacturing technique and used technology. In turn, the level of prices of agricultural products (but also prices of purchased inputs, which we take here under the principle of ceteris paribus) is an exogenous source because it is shaped regardless of the agricultural producer 11. Empirical illustration. The rate of income growth in agriculture in selected countries of the European Union is shown in Table 1. As we can see, when not taking subsidies into account, the rate of remuneration growth of labour factor is negative, which is due to the declining rate of labour productivity. The rate of labour productivity, accordingly ( W QZ W QZ ) should be connected with the rate of land factor productivity growth and changes in labour factor inputs. In the absence of practically any changes in employment of labour factor, the de facto lack of progress in the concentration, the rate of remuneration depended on changes in land factor productivity, which is showed in the following table. 11 Prices of agricultural products can be formed in at least two ways. Firstly, these could be market prices without considering the impact (support) of agricultural policy. This is the classical assumption that the market, market balance and the consequent and determining balance prices are the basis of the key mechanism regulating the choices or the behaviour of agricultural producers. Secondly, these could be intervention (minimum) prices, and thus containing support (subsidies) and having a strong income effect because, by definition, the level of these prices is higher than market prices. The literature concerning market intervention in agriculture is usually devoted mostly to that. This includes a whole range of methods we will not elaborate on that of support where the prices are the support transfer channel. From the point of view of this reasoning, it of course does not change the fact that the prices of agricultural products, regardless of the basis of their formation, is an exogenous source of income for the producer. 18

20 C Table 1. Rate of growth of labour remuneration in agriculture in C selected countries of the European Union in Countries elgium Czech Republic Germany Greece Spain France Italy Hungary The Netherlands Poland Sweden Great ritain Source: own calculations based on data from FAO, EUROSTAT. Table 2. Rate of growth of land productivity in selected countries of the European Union in Year Country elgium Czech Republic France Germany Greece Hungary Italy The Netherlands Poland Spain Sweden Great ritain Source: own calculations based on data from FAO, EUROSTAT. 19

21 Country Table 3. Changes in labour input (AWU) in selected countries of the European Union in (year t-1 = 1) Year Average change elgium % Czech Republic % France % Germany % Greece % Hungary % Italy % The Netherlands % Poland % Spain % Sweden % Great ritain % Source: own calculations based on data from FADN Concept of political rent The function of these effects of agricultural policy, or political rent: g() expressed in the formula (I.2) can be written down as follows: where: R g( ) T Z (I.15) T R T means the income effects associated with market intervention in the framework of the organization of common markets, expressed as the average level of income support per farm; T Z t expresses direct area payments per unit of area and the total area of the agricultural land within the farm at a given time, which has a direct impact on the income of agricultural producers. t We can assume that the expected income effects (payments) of agricultural policy are expressed by the following function: E g ( )] p ( t ) ( T Z ) (I.16) [ t 20

22 where: p t) p( f ( R )) p( f ( K, )) payments linked to production obtained ( t1 t1 t1 in the previous base period. The income effect of agricultural policy presented in the formula (I.16) expresses the essence of a political rent. It is associated with the expectation of support, somehow due by definition, which is associated with rational expectations. As demonstrated above, producers can be represented as a result of labour productivity and the level of prices of agricultural products, namely as: and: C R ) t t t ( C R W C R (I.17) t C W C t R (I.18) The actually realized income of producers must of course take into account the political rent t, so: C R C t (I.19) What is evident, the income actually realized result, firstly, from the labour productivity at given prices (endogenous source) and, secondly, are the result of direct payments (exogenous source). The above formula can also be written as: C R W C R t (I.20) Realized income is determined by the rate of labour productivity, the level of prices of agricultural products (purchase prices) and level of support and transfers. The formula (I.20) can be presented in a different way, i.e. by expressing separately producer-dependent factors labour productivity (at given prices) and independent ones support under the CAP. Hence we have (I.21): t C R W C R (I.21) 21

23 Assuming there is no change in labour productivity, agricultural producers incomes depend on: a) the level of prices received purchase prices; b) the level of direct payments area payments. This is a breakdown of the sources: market and policy-related (transfer-seeking). It is an obvious confirmation of the factual state. This approach is the basis for agricultural policy, especially income policy. The income effect of the policy can in fact be achieved either by prices or by direct transfers. The effect of the two solutions is essentially the same. We can only point to the different sources and effects of support through prices or direct support. Subsidies through prices charged consumers more, direct payments more affect taxpayers. However, in fact it is the same. Shares (in % or in the range of 0-1) of these sources of income can be expressed as follows: C 1 (I.22) C C R t R The level of the second component of the right side of the above formula, i.e. the share of payments in income, is already within the range of 50 to 80%. This applies to agriculture of most EU Member States, including the Polish agriculture, also in the system of area groups and the regional system. Empirical illustration. For the evaluation of the discussed political rent, i.e. income effects associated with support in the form of direct payments and other transfers, we show the cost and value of production, and the share of support in the value of production (Table 4, Figure 3, Figure 4). The evaluation was performed in individual groups of agricultural producers, i.e. with predominant livestock production (group a), with predominant crop production (group b), and without a specific type of production (group c) in the years In each of the analysed groups, there is a noticeable increase in the share of support in the value of production (the average level of income support per farm is increasing), which confirms the achievement of positive income effects. 22

24 Table 4. Share of support in the value of production in selected EU countries in Year Country elgium 9.13% 9.83% 11.40% 11.65% 12.22% 12.64% Czech Republic 13.63% 18.18% 23.13% 21.43% 25.14% 30.04% France 20.83% 21.28% 22.03% 18.82% 18.84% 20.89% Germany 18.01% 17.93% 18.55% 15.52% 16.81% 19.27% Greece 23.79% 22.89% 34.00% 30.73% 32.13% 33.95% Hungary 16.53% 19.52% 21.44% 19.31% 17.68% 24.91% Italy 10.14% 10.91% 11.80% 9.69% 9.78% 10.65% The Netherlands 3.33% 4.66% 4.65% 4.22% 4.01% 4.28% Spain 15.16% 16.81% 16.59% 13.01% 16.64% 19.92% Sweden 24.56% 24.82% 25.55% 22.38% 23.39% 27.94% Great ritain 23.53% 23.48% 23.38% 20.41% 19.14% 21.41% Source: own calculations based on data from FADN. Figure 3. Value of agricultural production and support of producers (PSE) in the EU in Euro billion ,50 0,45 0,40 0,35 0,30 0,25 0,20 0,15 0,10 0,05 0,00 Total czna value warto of production produkcji Support Wsparcieof producers producentów (PSE) The Udzia share of support wsparcia (PSE) in w the wartoci value of production produkcji Source: own calculations based on OECD Stats. As indicated by the analysis of the data presented in Table 5, in most of the countries of the EU the share of support in the production value increases or remains at a relatively constant level. The value of manufactured production in Great ritain is a notable exception, which has a decrease in the share of support. This may indicate an increase in management efficiency in the agricultural sector. In other cases, the increase of support in the production value, may be evidenced by comments on the relative substitution of progress in production efficiency. 23

25 Figure 4. Share of subsidies in income of family farms in Poland in for groups of farms with prevailing livestock (a), plant production (b) and without a separate type of production (c) 1,0 0,9 0,8 0,7 0,6 0,5 0,4 0,3 0,2 0,1 0, gospodarstwa farms with prevailing z przewaajc animal production produkcj (a) zwierzc (a) gospodarstwa farms with prevailing z przewaajc plant production produkcj (b) rolinn (b) farms gospodarstwa without bez distinguished wyodrbnionego type typu of production produkcji (c) (c) Source: own calculations based on data from FADN. Figure 5. Changes in the rates of area payments (in PN) in Poland in the period Complementary area payment Single area payment Source: ukowska M., Efekty WPR w odniesieniu do rolnictwa, [in:] Analiza efektów realizacji polityki rolnej wobec rolnictwa i obszarów wiejskich, Program Wieloletni, no. 26, Publ. IERiG-PI, Warsaw 2012, pp , p

26 Table 5. Changes in the rates of payments in the period (year t-1=1) Specification Year Single area payment Complementary area payment Total Source: own elaboration based on ukowska M., Efekty WPR, p. 76. The analysis of data presented in such a way is obvious and strengthens the comments and conclusions of analytical reasoning and the preceding empirical illustration. Payments, also in unit dimension, are becoming more significant. Moreover, this is accompanied by a steady increase in purchase prices. These considerations on the one hand do not force improvement of production efficiency and labour productivity as sources of income, on the other hand they may be a reflection of the lack of progress in this regard, which results from the analytical formulas and conclusions derived above. The increase in direct payments and maintaining product prices is a very favourable management condition for agricultural producers. This relative flexibility or softness of conditions and financial constraints, next to the positive effects, may have some negative consequences. It may, however, be a dangerous phenomenon in the long term because it undermines the preparation of agricultural producers to confrontation in terms of efficiency in an open global market with other producers in the face of the abolition of this type of support. They may, however, be neutralized due to the catalysing influence of political rent on implemented investment of agricultural producers, which is the theme of the last chapters of this monograph. 25

27 II. Substitution between economic and political rent The agricultural producer, following the terms of rational choice (also the mentioned rational expectations), uses more the source which is more favourable and less expensive for him. Improving the utilization of efficiency of used production factors at given pricing relationships is always difficult. Utilization of income effects of agricultural policy does not take place without effort either, but it seems to be cheaper. Therefore, we uphold the thesis that the producer, behaving rationally, may be willing to reach for cheaper and more effective solutions, the effects of agricultural policy, rather than the more expensive but more durable which is to improve efficiency. This will especially concern shorter periods, which in economics refers to periods in which technical changes are not possible or their results do not emerge Marginal rate of substitution of both rents To prove the aforementioned, let us assume that there is full and continuous substitutability of these two sources of income changes in an agricultural producer which we derived in the first chapter. Furthermore, we assume that we consider this phenomenon for a given level of the agricultural producer s income, or a fixed level of income in a given unit of time. Increasing the use of a single source (factor) without changing the level of income must therefore be made at the expense of reducing the use of another. As a result of these assumptions, the complete differential of agricultural producer s income in a given time: D f ( EP, ) max (II.1) is zero, so we have: U R U R du R EP 0 (II.2) EP where: U R EP EP means the income effect of improving the efficiency of production, that is, economic rent; 26

28 U R EP U can be defined as the marginal utility of improving the efficiency of agricultural producer incomes, that is from the point of view of the fulfilment of its objective functions; U R R means the income effect of increasing the scope of agricultural producer support under the CAP, that is political rent; can be defined as the marginal income utility of support under the CAP for the realization of the objective function of agricultural producer. The agricultural producer therefore optimizes his choice (reaches equilibrium) U R EP EP U R (II.3) that is when the benefits of measures meant to improve the production efficiency with respect to actions for the use of intervention benefits and any support get equalized. The producer equalizes the marginal utility of these two sources to improve his objective function 12. This condition means that the agricultural producer is in equilibrium, which means that he maximizes his objective function, that is income, when the income effect of the policy is equal to the loss of income effect as a result of deterioration in the production efficiency. This decrease in production efficiency stems from the fact that, as a result of support, the need to improve the efficiency decreased when compared to what it would be if this support was not there 13. We should also bear in mind that these are the relative and individual sizes because they are referred to the given level of production (at a given isoquant). An agricultural producer, behaving rationally, will choose the easier solution even though he may get dissuaded by more and more bureaucratic and cumbersome procedures (generating increasingly higher transaction costs) associated with obtaining a transfer within the agricultural policy tools. Furthermore, on the 12 Minus sign was omitted in this place not to suggest the direction of substitution between these two sources of improving income of the agricultural producer. 13 The direction of substitution discussed on the basis of the above formula can also be reversed, i.e. increasing income effects of efficiency improvement replace the need of support from the agricultural policy. However, it seems less likely. 27

29 basis of rational expectations, he can always expect matching the level of support to the deteriorating economic situation in agriculture, to decrease in profitability etc. usually, he gets great political, journalistic and scientific support here. Formally, the condition of substitution between these two sources of realization of the agricultural producer s objective function can be written as: s EP EP U R EP EP / U R (II.4) This rate of substitution is determined by the relation of utility of these two sources of income maximization for agricultural producers, utility understood as a source of obtaining this income. This approach can be called an attempt to describe the mechanism of behaviour or choice of agricultural producer in the conditions of the occurrence of an active agricultural policy focused on income goals Substitutability of effects of the policy and labour productivity ased on the above considerations, we can narrow the hypothesis and assume that income effects of agricultural policy substitute the need to improve the labour productivity. To put it illustratively, assuming that the complete differential of income: dc 0 (II.5) so that refers to the same level of income for the producer, and the lack of increase in prices: R C 0 (II.6) for we have: W t (II.7) 14 In fact, there is no other agricultural policy unless by agricultural policy one wants to pursue more general objectives as currently in the CAP objectives related to environmental protection, which is fashionably referred to as a matter of greening the CAP. 28

30 Then determining marginal gains of income against labour productivity and terms of payments to income, properly solving for the given level of income in the equation: C t R W C t and putting the above as marginal profitability of both of these sources, we obtain: W C W C t t (II.8) As a result, we can get the following rate of substitution between the two sources of income growth (implicitly for the their level): W t C t C W (II.9) The marginal rate of substitution of labour productivity by the effects of agricultural policy depends on the marginal impact of productivity performance and the effects on income, i.e. the relationship of marginal profitability. It is obvious that rationally behaving agricultural producers must be more focused on this source which has more, as defined in this way, marginal profitability. It can be assumed that the marginal impact of agricultural policy on income (their growth) is higher than the effect of improving labour productivity in this field: C W C t (II.10) C It seems that estimates confirm this because: t amounted in 2010/2009 to 1.6; that is one unit (one PN) of subsidy growth corresponded to income C growth by 1.6 PN, while the indicator: W was indefinite because labour 29

31 productivity did not increase (decreased), which also indicates a lack of association between changes in remuneration and labour productivity Cost of obtaining income effects of both rents This rate of substitution conditioned, as shown above, by the relation of marginal utility of improving the production efficiency (economic rent) and agricultural policy (political rent) for income needs to be compared with the costs of obtaining these utilities. However, it is not easy with this because it is difficult to establish a limit on these costs as a condition for the objective function of the manufacturer due to these two factors discussed. It would be easier to determine the cost of the marginal utility of improving the efficiency than the cost of obtaining this utility under policy (participation in the specific programs or mechanisms). This requires additional analysis and studies. Here, only to outline the direction of reasoning, we can assume as follows. The total cost associated with the release of these sources of income can be defined as: where: kd EP kd EPkd (II.11) EP kd costs of obtaining the income effects from economic rent, kd costs of obtaining the income effects from political rent. Assuming that costs of using both rents defined in that way have a size given in advance (a limit at a given time t), their complete differential is equal to zero, i.e.: d ( kd) EPkd kd 0 (II.12) EP Thus, the cost of marginal rate of substitution of income effect of economic and political rents will be as follows: EP kd EP sep / (II.13) kd It is a condition of the optimum producer s choice due to the two analysed factors for maximization of income as the objective function. 30

32 It is easy to assemble these marginal rates of substitution to get the idea about the mechanism of producer s choice in the field of rents discussed here as sources of income and its maximization. We can probably assume that: kd EP kd (II.14) As we can assume, this prejudges the direction of substitution in the analysed range of both rents. It can be interpreted as the situation in which political rent somehow displaces the economic rent Elasticity of substitution of economic and political rent We can deepen the analysis of the issue of substitution of both rents by introducing the elasticity of substitution. We can assume for a given level of earned income D R f { EP, ) DR certain shares of both analysed rents, i.e. political rent and economic rent, and cost, respectively as: EPk D EP R (II.15) and k D R E t D(, Z ) G( gd, G ) (II.16) Thus, the relationship between shares of both rents and the cost will be as follows: EPk D k D EP R R EPk k EP EP k k EP (II.17) These relations of both rents in the producer s income are determined by the relationship of costs to obtain them. This indicates that the substitutability of the two rents is reported against the cost of obtaining them. 31

33 This formula has essentially the same importance as the ratio of substitution elasticity, in this case the economic and political rent to achieve the same level of income in relation to changes in the cost of obtaining them. If the marginal rate of substitution is put as above, substitution rate of both rents is equal to the inverse of the cost of obtaining them. Thus, the above expression in the convention of substitution elasticity (arc or at intervals) can be written as: ( EP / ) Ep / ( k / k ) EP k / k EP (II.18) The share of both rents in the forming income is flexible or varies with respect to changes in the cost of obtaining them. It can be assumed that the cost of obtaining income effects from economic rent, i.e. to improve the production efficiency is higher than the cost of obtaining the effects of political rent. Hence the elasticity of substitution of economic rent by political rent is high. The direction of substitution of economic rent by political rent as a source of income is easy to predict. This is showed in the following transformation of the above formula of elasticity substitution: ( k / kep ) 1 ( EP / ) k / k EP / EP (II.19) The direction of changes in the share of both rents in shaping income is determined by changes in the relationship of costs of obtaining income effects of both rents. This follows from the relationship, and the rate of cost substitution shown above. The elasticity of substitution costs and effects is inversely proportional Demand and costs of obtaining income effect from both rents At the given cost limit for a given income, it can be assumed that the producer s choice of the discussed rents as a source of income will create his demand on these rents. In the corresponding transformation of the cost equation, we have: kd EPkd (II.20) EP kd 32

34 where: kd total cost of obtaining the income effect from economic and political rents, kd EP total cost of obtaining the income effect from improvement of production efficiency from economic rent, kd total cost of obtaining the income effect from political rent with solutions and mechanisms of agricultural policy. Hence we obtain the equation of agricultural producer s demand for alternative in a sense, which results from the limitations of this equation income sources which are the discussed income effects of increasing efficiency and agricultural policy. So we have: kd kd EP EP (II.21) kd kd This means that the demand for income effects of agricultural policy is determined by the relative cost of obtaining these effects, i.e. in relation to the total cost of obtaining income and in relation to the alternatives (substitution) costs of obtaining income effects from efficiency improvements at its given level. In fact, it expresses the discussed contemporary decision-making dilemma of agricultural producer of how many income benefits there are of the solutions of agricultural policy in relation to the efforts to improve efficiency. The analysis of the following equation, only in the opposite direction, has a similar nature. kd kd EP (II.22) kd kd EP EP The dependencies described with the abovementioned formulas which affect the producer s choice are substitutable. This can be interpreted in the following way. An increase in the cost of obtaining income effects due to improvement of production efficiency in relation to the costs of obtaining income effects in relation to the total cost as limitations will of course make producers to orient themselves and increase the demand for the solutions of agricultural policy as a source of income, and will reduce the demand for pro-efficiency action. The conclusion is in accordance with the intuitive perception and explanation of real economic phenomena. It is also consistent with the assumption of rational adaptive behaviour of the 33